Knowledge that Transforms

Monetary policy analyses usually assume an atomistic private sector, thereby ignoring potential interactions between policy and wage-setting decisions. Yet, non-atomistic wage setters are a key feature of several industrialized economies. We study the economic consequence of non-atomistic agents and show that this qualifies previous results on the effects and desirability of a conservative central banker. In particular, the central bank aversion to inflation may have a permanent effect on structural employment, while no such effect emerges with atomistic agents.

We compare the characteristics of real-world financial contracts to their counterparts in financial contracting theory. We do so by studying the actual contracts between venture capitalists (VCs) and entrepreneurs. The distinguishing characteristic of VC financings is that they allow VCs to separately allocate cash flow rights, board rights, voting rights, liquidation rights, and other control rights. We describe and measure these rights. We then interpret our results in relation to existing financial contracting theories. We also describe the interrelation and the evolution across financing rounds of the different rights.

We propose a model of organizational decision making, in which information processing is decentralized. Our model incorporates two features of many actual organizations: aggregation entails a loss of useful information, and the decision problems of different agents interact. We assume that an organization forms a portfolio of risky assets, following a hierarchical procedure. Agents' decision rules and the organization's hierarchical structure are derived endogenously. Typically, in the optimal hierarchical structure, all agents have one subordinate, and returns to ability are at least as high at the bottom as at the top. However, these results can be reversed in the presence of returns to specialization. Copyright 2003, Wiley-Blackwell.

This paper studies the impact of an unfunded social security system on the distribution of altruistic transfers in a framework where savings are due to both life cycle and random altruistic motivations. We show that the effect of social security on the distribution of these transfers depends crucially on the strength of the bequest motive in explaining savings behaviour. We measure this strength by the expected weight that individuals attach to the utility of future generations. On the one hand, if the bequest motive is strong, then an increase in the social security tax raises the bequests left by altruistic parents. On the other hand, when the importance of altruism in motivating savings is sufficiently low, the increase in the social security tax could result in a reduction of the bequests left by altruistic parents under some conditions on the attitude of individuals toward risk and on the relative returns associated with private saving and social security. Some implications concerning the transitional effects of introducing an unfunded social security scheme are also discussed.

In this paper, we consider an environment in which agents ’ productivities are private information, potentially multi-dimensional, and follow arbitrary stochastic processes. We allow for arbitrary incentive-compatible and physically feasible tax schemes. We prove that it is typically Pareto optimal to have positive capital taxes. As well, we prove that in any given period, it is Pareto optimal to tax consumption goods at a uniform rate. All, University of Minnesota and the Federal Reserve Bank of Minneapolis. Kocherlakota acknowledges the

This paper asks whether statistical discrimination is a market failure. I consider the problem for a utilitarian social planner who operates in an environment that can generate statistical discrimination as an equilibrium phenomenon. It is found that there are potential efficiency gains from discrimination in terms of reduced "mismatch" between workers and jobs. Whether the solution to the planning problem involves discrimination depends on the trade-off between the informational gains of specialization and the losses in terms of increased investment costs. Copyright 2003, Wiley-Blackwell.

The implications of the Minimax theorem are tested using natural data. The tests use a unique data set from penalty kicks in professional soccer games. In this natural setting experts play a one-shot two-person zero-sum game. The results of the tests are remarkably consistent with equilibrium play in every respect: (i) winning probabilities are statistically identical across strategies for players; (ii) players' choices are serially independent. The tests have substantial power to distinguish equilibrium play from disequilibrium alternatives. These results represent the first time that both implications of von Neumann's Minimax theorem are supported under natural conditions. Copyright The Review of Economic Studies Limited, 2003.

We explore entry into a foreign market with uncertain demand growth. A multinational can serve the foreign demand by two modes, or by a combination thereof: it can export its products, or it can create productive capacity via foreign direct investment (FDI). The advantage of FDI is that it allows for lower marginal cost than exporting does. The disadvantage is that FDI is irreversible and, hence, entails the risk of creating under-utilized capacity in the case that the market turns out to be small. The presence of demand uncertainty and irreversibility gives rise to an interior solution, where the multinational, under certain conditions, both exports its products and does FDI.

This paper shows that supervision with soft information is valuable whenever supervisors and supervisees collude under asymmetric information and proceeds then to derive an Equivalence Principle between organizational forms of supervisory and productive activities. We consider an organization with an agent privately informed on his productivity and a risk averse supervisor getting signals on the agent's type. In a centralized organization, the principal can communicate and contract with both the supervisor and the agent. However, these two agents can collude against the principal. In a decentralized organization, the principal only communicates and contracts with the supervisor who in turn sub-contracts with the agent. We show that the two organizations achieve the same outcome. We discuss this equivalence and provide various comparative statics results to assess the efficiency of supervisory structures. Copyright 2003, Wiley-Blackwell.

This paper develops a welfare-based model of monetary policy in an open economy. We examine the optimal monetary policy under commitment, focusing on the nature of price adjustment in determining policy. We investigate the implications of these policies for exchange-rate flexibility. The traditional approach maintains that exchange-rate flexibility is desirable in the presence of real country-specific shocks that require adjustment in relative prices. However, in the light of empirical evidence on nominal price response to exchange-rate changes—specifically, that there appears to be a large degree of local-currency pricing (LCP) in industrialized countries—the expenditure-switching role played by nominal exchange rates may be exaggerated in the traditional literature. In the presence of LCP, we find that the optimal monetary policy leads to a fixed exchange rate, even in the presence of country-specific shocks. This is true whether monetary policy is chosen cooperatively or non-cooperatively among countries.